Monday, July 21, 2014

Big Banks Hit With Monster $250 Billion Lawsuit in Housing Crisis

This piece first appeared at Web of Debt.For years, homeowners have been battling Wall Street in an attempt to
recover some portion of their massive losses from the housing Ponzi
scheme. But progress has been slow, as they have been outgunned and
out-spent by the banking titans.

In June, however, the banks may have met their match, as some equally powerful titans strode onto the stage. Investors led by BlackRock,
the world’s largest asset manager, and PIMCO, the world’s largest
bond-fund manager, have sued some of the world’s largest banks for
breach of fiduciary duty as trustees of their investment funds. The
investors are seeking damages for losses surpassing $250 billion. That
is the equivalent of one million homeowners with $250,000 in damages
suing at one time.

The defendants are the so-called trust banks that oversee payments
and enforce terms on more than $2 trillion in residential mortgage
securities. They include units of Deutsche Bank AG, U.S. Bank, Wells
Fargo, Citigroup, HSBC Holdings PLC, and Bank of New York Mellon Corp.
Six nearly identical complaints charge the trust banks with breach of
their duty to force lenders and sponsors of the mortgage-backed
securities to repurchase defective loans.

Why the investors are only now suing is complicated,
but it involves a recent court decision on the statute of limitations.
Why the trust banks failed to sue the lenders evidently involves the
cozy relationship between lenders and trustees. The trustees also
securitized loans in pools where they were not trustees. If they had
started filing suit demanding repurchases, they might wind up sued on
other deals in retaliation. Better to ignore the repurchase provisions
of the pooling and servicing agreements and let the investors take the
losses—better, at least, until they sued.

Beyond the legal issues are the implications for the solvency of the
banking system itself. Can even the largest banks withstand a $250
billion iceberg? The sum is more than 40 times the $6 billion “London
Whale” that shook JPMorganChase to its foundations.

Who Will Pay – the Banks or the Depositors?

The world’s largest banks are considered “too big to fail” for a
reason. The fractional reserve banking scheme is a form of shell game,
which depends on “liquidity” borrowed at very low interest from other
banks or the money market. When Lehman Brothers went bankrupt in 2008,
triggering a run on the money market, the whole interconnected shadow
banking system nearly went down with it.

Congress then came to the rescue with a taxpayer bailout, and the
Federal Reserve followed with its quantitative easing fire hose. But in
2010, the Dodd Frank Act said there would be no more government
bailouts. Instead, the banks were to save themselves with “bail ins,”
meaning they were to recapitalize themselves by confiscating a portion
of the funds of their creditors – including not only their shareholders
and bondholders but the largest class of creditor of any bank, their depositors.

Theoretically, deposits under $250,000 are protected by FDIC deposit
insurance. But the FDIC fund contains only about $47 billion – a mere
20% of the Black Rock/PIMCO damage claims. Before 2010, the FDIC could
borrow from the Treasury if it ran short of money. But since the Dodd
Frank Act eliminates government bailouts, the availability of Treasury
funds for that purpose is now in doubt.

When depositors open their online accounts and see that their
balances have shrunk or disappeared, a run on the banks is likely. And
since banks rely on each other for liquidity, the banking system as we
know it could collapse. The result could be drastic deleveraging,
erasing trillions of dollars in national wealth.

Phoenix Rising

Some pundits say the global economy would then come crashing down. But in a thought-provoking March 2014 article called “American Delusionalism, or Why History Matters,” John Michael Greer disagrees. He notes that historically, governments have responded by modifying their financial systems:

Massive credit collapses that erase very large sums of
notional wealth and impact the global economy are hardly a new
phenomenon . . . but one thing that has never happened as a result of
any of them is the sort of self-feeding, irrevocable plunge into the
abyss that current fast-crash theories require.

The reason for this is that credit is merely one way by which a
society manages the distribution of goods and services. . . . A credit
collapse . . . doesn’t make the energy, raw materials, and labor vanish
into some fiscal equivalent of a black hole; they’re all still there, in
whatever quantities they were before the credit collapse, and all
that’s needed is some new way to allocate them to the production of
goods and services.

This, in turn, governments promptly provide. In 1933, for example,
faced with the most severe credit collapse in American history, Franklin
Roosevelt temporarily nationalized the entire US banking system, seized
nearly all the privately held gold in the country, unilaterally changed
the national debt from “payable in gold” to “payable in Federal Reserve
notes” (which amounted to a technical default), and launched a series
of other emergency measures. The credit collapse came to a screeching
halt, famously, in less than a hundred days. Other nations facing the
same crisis took equally drastic measures, with similar results. . . .

Faced with a severe crisis, governments can slap on wage and price
controls, freeze currency exchanges, impose rationing, raise trade
barriers, default on their debts, nationalize whole industries, issue
new currencies, allocate goods and services by fiat, and impose martial
law to make sure the new economic rules are followed to the letter, if
necessary, at gunpoint. Again, these aren’t theoretical possibilities;
every one of them has actually been used by more than one government
faced by a major economic crisis in the last century and a half.

That historical review is grounds for optimism, but confiscation of
assets and enforcement at gunpoint are still not the most desirable
outcomes. Better would be to have an alternative system in place and
ready to implement before the boom drops.